The song remains the same, and it will for the foreseeable future. The Federal Reserve will not be raising rates until probably late 2022, so we remain in a setting with coupons on government securities still close to generational lows. Certificates of deposit at banks are wretched, with the best five-year rate we could find at a paltry 1.4%, and that was for a $100,000 deposit. Quality investment-grade corporate and municipal bonds? Same story.
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So what are balanced growth and income investors to do? The potential for capital appreciation on low-coupon bonds is negligible, and with the market possibly primed for a big sell-off, risky high-yield or leveraged funds don’t make any sense for those with low risk tolerance. What does make sense is looking at the business development stocks that pay outsized dividends and offer growth potential.

Business development companies (BDCs) are organizations that invest in small and medium-sized companies to help them grow in the initial stages of their development. BDCs also help distressed businesses regain a sound financial footing.

Jefferies analysts are very positive on four top BDCs. They said this about the industry’s solid second quarter and prospects for the rest of the year:

2Q results were positive as the strong deal environment from 1Q carried over, while repayment levels have not been as elevated as some feared. Non-accruals at cost declined 65 bps Q/Q for BDCs under coverage, marking the fourth consecutive decline for the group, however, we are confident that the worst is in the rearview mirror, given four consecutive quarters of non-performing-assets reductions in the context of the recovering and expanding economic backdrop. Further, we pointed out that while spreads have made a meaningful recovery to pre-COVID levels, portfolio yields remained stable in 2Q and increased supply is being digested by a growing demand. Over the LT, we believe well-positioned BDCs will perform favorably and we recommend investors remain selective as valuations appear to be more accurately reflecting robust trends observed in 2Q.

While all four stocks are rated Buy at Jefferies, it is important to remember that no single analyst report should be used as a sole basis for any buying or selling decision.

Ares Capital

This is a favorite BDC across Wall Street. Ares Capital Corp. (NASDAQ: ARCC) is a leading specialty finance company that provides one-stop debt and equity financing solutions to U.S. middle-market companies, venture capital backed businesses and power generation projects. Ares Capital originates and invests in senior secured loans, mezzanine debt and, to a lesser extent, equity investments through its national direct origination platform. The company’s investment objective is to generate both current income and capital appreciation through debt and equity investments primarily in private companies.

Top Wall Street analysts believe the strength of the company’s origination platform, sizable balance sheet and ample liquidity position it favorably in a very competitive investing environment. Some believe that with the current tight spread environment Ares Capital has the scale and industry relationships to continue to make competitive, high-credit-quality investments.

Investors receive an 8.30% dividend. The Jefferies price target for the shares is $22, while the Wall Street consensus target is $21.27. Ares Capital stock closed at $19.76 on Friday.

This off-the-radar BDC offers solid total return potential. Barings BDC Inc. (NYSE: BBDC) is a publicly traded, externally managed investment company. It seeks to invest primarily in senior secured loans to private U.S. middle-market companies that operate across a wide range of industries.
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The company specializes in mezzanine, leveraged buyouts, management buyouts, ESOPs, change of control transactions, acquisition financings, growth financing and recapitalizations in lower middle market, mature and later-stage companies. Barings BDC’s investment activities are managed by its investment adviser, Barings, a leading global asset manager based in Charlotte, North Carolina, with over $335 billion of assets under management firmwide.

Shareholders receive a 7.73% dividend. Jefferies has a $12 price target, and the consensus target is $11.68. Friday’s closing print was $10.86.

Hercules Capital

This is another highly regarded BDC across Wall Street. Hercules Capital Inc. (NYSE: HTGC) is the largest non-bank lender to venture capital-backed companies at all stages of development in a broadly diversified variety of technology, life sciences and sustainable and renewable technology industries.

With over a decade of experience in venture debt, Hercules is uniquely positioned to quickly create innovative financing solutions that perfectly fit within a company’s existing capital structure and map to its business objectives. Recognized as the industry leader, Hercules understands the flexibility these types of companies need and has the experience to work closely with them, even through challenging times, to help them reach critical milestones.

Its deep sector expertise, geographic presence and strong capital base have made Hercules the lender of choice for more than 480 innovative companies.

Shareholders receive a $7.66% dividend. The $20 Jefferies price target is higher than the $18.44 consensus target. The stock closed on Friday at $16.70.

Oaktree Specialty Lending

This lower-priced stock offers investors the ability to buy more shares. Oaktree Specialty Lending Corp. (NASDAQ: OCSL) specializes in investments in middle-market, bridge financing, first and second lien debt financing, mezzanine debt, senior and junior secured debt, expansions, sponsor-led acquisitions and management buyouts in small and mid-sized companies.

The fund seeks to invest in education services, business services, retail and consumer, health care, manufacturing, food and restaurants, construction and engineering, and media and advertising segments. It invests between $5 million to $75 million principally in the form of one-stop, first lien, and second-lien debt investments, which may include an equity co-investment component in companies with enterprise value between $20 million and $150 million and EBITDA between $3 million and $50 million. The fund has a hold size of up to $75 million and may underwrite transactions up to $100 million. It primarily invests in North America. The fund seeks to be a lead investor in its portfolio companies.

Investors receive an 8.11% dividend. Jefferies has set an $8 price target. The $7.57 consensus target is closer to Friday’s closing price of $7.15.

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While the Jefferies price targets are not sky-high, combined with the strong dividends, the total return possibilities for all of the companies look to be very solid. Given the sector has also been somewhat out-of-favor, the risk/reward also looks compelling.

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